Discounted cash flow and business valuation in a nineteenth century merger: A note

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The Accounting Historians Journal Vol. 8, No. 2 Fall 1981
J. R. Edwards and
Alison Warman UNIVERSITY COLLEGE, CARDIFF
DISCOUNTED CASH FLOW AND BUSINESS VALUATION IN A NINETEENTH CENTURY MERGER:
A NOTE
Abstract: In 1889 the Shelton Iron, Steel and Coal Company Limited was incorpo-rated to take over the assets and business activities of two existing companies. To guide the contracting parties in negotiating a price to be paid for the properties belonging to the Shelton Collieries and Ironworks an independent valuation was arranged by Deloitte, Dever, Griffiths & Co., later appointed auditors of the new company. The article comprises an appraisal of the valuation exercise, which is an early example of the use of a discounted cash flow technique to provide rele-vant information for a capital investment decision.
Discounted cash flow (DCF) criteria have been applied to insur-ance matters and financial investments for several centuries, but it is only during the present century that they have gained wide-spread theoretical acceptance for capital investment purposes. Capital value theory was developed by economists such as Irving Fisher and Alfred Marshall in the 1920s, leading to formal exposi-tions of the net present value (NPV) rule and the internal rate of return (IRR) model by P. A. Samuelson and K. Boulding respective-ly in the 1930s.1 However, employment of these techniques as part of the decision-making process within United Kingdom companies is not as widespread as might be expected and is sometimes sup-posed to be the case. G. D. Newbould's study of takeover and merger activity in the late 1960s2 showed that none of the com-panies included in his survey had made use of DCF techniques to value an enterprise, either as a means of assessing the viability of a prospective investment or as a means of retaliating against a low bid. The most popular methods of valuation, identified by Newbould, were book or market values of assets and current market prices of securities. Comparison of price earnings ratios was also favoured as a means of assessing a prospective investment. Judged theoretically, each of these methods is considered to be sub-optimal.